Speaker, author and management consultant Peter Drucker once said, “You can’t manage what you don’t measure”.
When it comes to your finances that measurement is cash flow.
In this post, I’ll cover how to manage cash flow, what options you have to increase cash flow, and how to improve cash flow overall.
Think about it…you track your weight loss by measuring how many pounds you’ve lost, right?
If you’re trying to get better with money, wouldn’t you want to do something similar?
That’s where cash flow comes in.
So what is cash flow?
So what exactly is cash flow? It’s the flow of money in and out of your business, or in our case, your personal finances. The money left over after all expenses are paid is your “monthly cash flow”.
The formula is super simple…. Monthly Income – Monthly Expenses = Monthly Cash Flow
Often times it’s discussed in the context of managing the cash flow for a business, but conceptually it’s the exact same thing.
How to calculate cash flow
Let’s take a look at a few examples of how to calculate cash flow.
- Current Monthly Income: $4000
- This would be the amount after taxes and other withholdings e.g. insurance, HSA, retirement, etc.
- Current Monthly Expenses:$3000
- e.g. housing, food, clothing, utilities, debt servicing, etc, is $3000 a month.
- monthly income $4000 – monthly expenses $3000 = $1000
- Your monthly cash flow is $1000
- Now let’s say your income went up to $500 a month…
- monthly income $4500 – monthly expenses $3000 = $1500
- Your monthly cash flow would be $1500
- How about if your expenses went up to $500
- monthly income $4000 – monthly expenses $3500 = $500
- Your monthly cash flow would be $500
So why is it important to know?
Well for one, if you want to know how to manage cash flow, you first need to know what it is. And as you increase cash flow, you accelerate your ability to a number of things like:
- Accelerate your snowball and pay down more principal on your debt
- Establish a 6-month emergency fund
- Start to invest for your retirement/future
It’s also extremely powerful for making decisions and getting motivated since it lets you quickly identify how long something will take and plan accordingly.
Let’s say you have a monthly cash flow of $1000.
- How long will it take to save up an emergency fund of $5000? 5 Months
- How long to save up for an $8000 car? 8 Months
- How long to pay off $25,000 in Student Loans? 25 Months
What if you increase your cash flow to $2000?
- How long will it take to save up an emergency fund of $5000? 2.5 Months
- How long to save up for an $8000 car? 4 Months
- How long to pay off $25,000 in Student Loans? 12.5 Months
The time to do any of them gets cut in half. That’s some powerful stuff.
How to improve your cash flow
So how do we increase our monthly cash flow from $1000 to $2000 or higher? The beauty of knowing the formula is that you already know the answer.
There are only two levers you can pull here to do this. You either increase your monthly income and/or reduce your monthly expenses.
Increase your monthly income
- Ask for a raise…this is the most impactful thing you can do assuming they say yes 🙂
- Take on a part-time job…deliver pizzas, drive for Lyft, mow yards.
- Reduce your paycheck withholdings like 401k*
- Start an online business like selling things on eBay or Etsy…how about that old comic collection?
- *Reduce your paycheck withholdings like 401k
*There are different schools of thought on this subject. One of the most well known personal finance coaches Dave Ramsey recommends stopping all investing when you are getting out of debt.
I believe this is a case-by-case decision and you should take into consideration things like employer match, amount of debt, and commitment to getting out of debt fast.
It’s a tough choice, and everyone feels different about it. That what makes this PERSONAL finance.
Reduce Your Monthly Expenses
- Reduce your must-haves expenses, take on a roommate, reduce your grocery bill, sell your car.
- Reduce your nice-to-haves by cutting the cord..no cable, no new clothes, no eating out.
- Pay off your debts – every debt you pay-off increases your monthly cash flow.
How to manage cash flow
When you are first starting out, the majority of the energy you spend on learning how to manage cash flow be focused on expense reduction since it provides you much more immediate number then working on increasing your income.
The quickest way to do this is through the creation of a zero-dollar budget, where prior to the month beginning you sit down and…
- First, write down all the money coming in for the month (paychecks, side hustles, etc)
- Then, write down all your monthly expenses starting with must-haves like food and shelter, all your monthly debt payments, and then nice to haves like new clothes, or eating out.
- Subtract all your expenses from your income, and with whatever remaining cash flow you have, apply it against your smallest debt if you are using the debt snowball strategy.
Now that you have a better understanding of what monthly cash flow is, and the power it has over your personal finances, I’d recommend doing one of two things.
- If you haven’t created a budget yet, DO IT! This tool enables you to understand the composition of your cash flow at a very granular, and actionable level and you’ll be able to identify exactly what is your low hanging fruit for increasing it. If you don’t measure something you won’t ever be able to manage it.
- If you’ve already created a budget, you should pull it up now. You’re probably going to see each of your expenses as a potential way to increase cash flow. Once you start seeing those, you’ll be empowered to make real, quick changes to improve it like canceling the unused gym membership, reducing your cable package, or cutting back on grocery spending.
So what do you think? Do you have any tips? Let us know by leaving a comment below. The more we share the more we all can learn.